A make-believe crisis in the stock market

January 20, 2011

photo:bdnews24.com

A number of newspapers recently reported that in the past few days, nationalised commercial banks and financial institutions have been actively buying in the stock market in order to â€śbring normalcyâ€ť to the market. I guess the definition of normalcy is price appreciation every week in the magnitude of 2-3 percent, for an annual return of over 100 percent. Otherwise, in a market that has a price to earning (PE) ratio of over 30, how does the fall of stock prices by a mere 15 percent in total can be construed anything but normal?

Even after recent corrections, the PE ratio is over 25. Putting in perspective, if investors depend only on earnings of the invested companies for return OF their capital (let alone any return ON capital), they would have to wait a long 25 years. No other comparable stock markets have a PE ratio over 20. In the past 10 years, even Bangladesh stock market traded at a long-term average PE of 20. If such is the case, why a market that is overvalued by at least 25 percent needs state support? When correction in the market is overdue and is actually a healthy development, why the state is pouring good money into a flawed system, and to whose benefit?

What bothers me most is the mode of the intervention. The news reports state that the Investment Corporation of Bangladesh (ICB) received Tk 2.0 billion (200 crore) â€śfinancial assistanceâ€ť from the central bank to intervene in the market. ICB used this money, along with its own funds as well as funds from its mutual fund portfolios to purchase stocks whose prices were falling. I guess the same is true for other state-owned banks and financial institutions, as well as some private financial institutions.

The whole process is wrong, offensive, foul and reckless in a number of ways. First, this is a clear transfer of state funds to speculators without any accountability. Bangladesh capital market is nowhere near to being an important contributor to national growth that it would have to be propped up by transferring public wealth to rowdy speculators.

Second, there seems to be no accountability or policy direction by the government for ICB or others as to what securities should be purchased with this â€śfinancial assistanceâ€ť. It means these parastatals can use this fund to purchase any stocks they wish to please any group of investors they want.

Third, ICB is reported to have used cash from their mutual fund portfolios to purchase stocks whose prices were falling. The assets and the cash in the mutual fund portfolios do not belong to the ICB, to the ministry of finance or to the government. They belong to the mutual fund investors. What right does the ICB have to use their money and hurt their interests while implementing governmentâ€™s policy decisions? This is a gross violation of investorsâ€™ constitutional right to own assets without government meddling.

Finally, what is a normal state of the market where such intervention stops, at a PE ratio of 100? By a process called â€śreversion to meanâ€ť, the market shall and must come down to a realistic level, no matter what the size of the intervention. In this case, normalcy may mean a historical PE ratio of 20 or lower. By postponing the day of reckoning, what does the government achieve?

It is understandable that a political government would not want another stock market crash on its watch, and it would do everything to avoid such embarrassment. However, such embarrassment could be nipped in the bud many months ago. The whole affair started with banksâ€™ excessive venture in the stock market. As soon as the market PE surpassed the historical average, the central bank should have slowly limited banksâ€™ exposure. Instead, platitude substituted for sound policies. When the horse left the burn, the central bank has been forced to take (or withdraw) measures, which are ignominious to the prestige of the institution.

Instead of banks having to adjust by January 15 their loans diverted from industrial accounts to stock market, they now have unlimited time. A time-tested safeguard such as single borrower exposure limit has been relaxed. Finally, it is reported that the central bank has been asking banks not to sell their shares in a depressed market. Since when is it the job of the central bank to maintain the level of stock prices? Sooner or later the market would adjust downward and the banks would be left with losses from these investments. Is a weaker banking system more desirable than a weaker stock market? It appears that the discipline achieved through the Banking System Reform of the last decade could be lost while trying to defend a weak capital market.

The knee-jerk, reactive policymaking that is the hallmark of the Securities and Exchange Commission (SEC) seems to have spread upwind. I would also put the blame squarely on the media that unnecessarily magnified the stock market and its subsequent fall. Robert Shiller in his book â€śIrrational Exuberanceâ€ť attributes excessive media coverage of the stock market as one of the causes for speculative bubbles. That surely was the case in our market. The recent market correction should have been ignored and viewed as what it was â€” a necessary lesson for foolhardy speculators. Instead, we are wasting valuable time, resources and political capital to remedy a make-believe crisis.

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7 Responses to “ A make-believe crisis in the stock market ”

Md. Sahadath Hossain on January 22, 2011 at 2:16 am

Dear writer,
We have seen correction during 2008 when index used to reach up to 2700/2800 level then gradually declined to 2300/2400 level. That was real correction…..but what happened in last one and half a month is nothing but mere crashâ€¦which even surpassed the debacle of 1996 compared to market capitalisation size.
Another thing fin institutions made a huge profit during 2007-2010 and this profit is being blocked by Bangladesh Bank since the fin institutions had to form subsidiary to operate capital market activities. You know this is formal way to stop siphoning money to capital market which ultimately stopped informal way of money flow.
The crash should have not been overlooked because many people have become penniless overnight due to the dip.
Let me give you an example of the situation, one investor opened an account with Tk 2.13 crore in July 2010, in January 17, 2011 that man had equity of Tk 20.1 lakh only. This is just one example, there are thousands of such instances.

If most of us knew that the market would drag to 6000 on Index within February, then this is a preplanned game. Some people will benefit from the situation. This is not market correction, this is an act of some ‘vested’ investors.

Dear writer, I guess it is not so difficult to go by the book and put in a theoretical assessment of things rather than a practical one.

I myself am an investor both in the capital market and in the industrial sector. When the government is having a hard time to provide power and other utilities to run our existing setup, how do you expect us to invest more into it for expansion?

In the initial part of last year, the government actually encouraged us to get involved in the stock market so that it can turn into something substantial (as in stronger economies of the world) and contribute to the economy as a whole. So how do you expect us to digest such a drastic fall in such a short time?

I admit that the share prices soared at an alarming rate but why then were the banks not monitored and allowed to go beyond their exposure limit? Although the size of our portfolio increased fast during that time, we ourselves weren’t happy with the market trend.

If you have any experience with stock markets in stronger economies then you will understand that market correction usually happens at similar rates to that of the initial price increase; anything more than that is termed as alarming. So how on earth can you term a 600 point fall in 5 minutes as normal?

If you don’t have any idea about what happened on that day, FYI extreme sell pressures came from certain trading houses at a rate that is far lower than that was offered by the buyers. For example for a certain stock even if there were substantial Buy orders for Tk 330, there were huge Sell orders for Tk 300 or lower. Don’t you think all these are parts of a manipulation game?

And interestingly you term these occurring as “NORMAL”. Funny! I would request you to get your facts right before you take on the effort of posting such an article on such a sensitive issue.

Dear Mr. Hamidullah
First of all this is not a correction this is a disaster. The economy doesnâ€™t show any dynamic progress in the last year the index could reach 9000 point. There was no investment opportunity. Lack of power & gas resources. Lots of money in the hand of banks & other financial institutes. But no investment, no capital machinery import. They came to share market. They cross the 10% exposure. The mass people have no choice. Unemployment, only 9% FDR interest, electricity, gas crisis forced them to come to share market & earn some money.

Than there was created an artificial bubble. Some people make the stock market bullish and make the mass people foolish. The people driven through greed and now the drive through fear. The people have been looted. They lost their hard earn money, their fate, their hope. As one of them I want the culprit to be trialed. This is not a normal correction. Nothing happened to the economy. Itâ€™s running well. But look at the stock market. What is happening there?

The government gives responsibility to the SEC but they didnâ€™t play their role properly. A political government canâ€™t say we donâ€™t have any headache. We donâ€™t desire a weaker banking system than a weaker stock market. We want the case should be investigated properly and the culprit should be punished.

A soft landing of the overheated market should be ensured (just like the landing of a flying aircraft in the sky) through appropriate policy decisions and direct intervention by the government to provide a floor of the general index in this crisis situation.

Some good observations. But does this tiny stock market matter for economic growth of Bangladesh? Not so. Then why worry so much about it? We worry for the small investors who thought due to lack of financial literacy that stock prices will keep going up forever and they can always make money. They need to be educated that in stock market there are always chances of loss and gain (pain and pleasure). With limited hard-earned savings/borrowed money they should not have gambled in this casino.

A few large institutional investors (mainly banks and large industrialists who also own some banks) kept inflating the market for a while by pouring in money into it. This enticed small investors who had a dream to be rich quickly. As the market peaked, the big players started selling stocks for abnormal profit and subsequently the market plunged. The market was manipulated, no doubt. The behaviour was not normal in relation to P/Es and macroeconomic fundamentals. So, it is not a natural correction of the market. This rather created panic and crisis of confidence. In fact, this is a policymakers-made debacle. They are again making the same mistakes to jump-start the market by funnelling money and asking ICB as well as state-owned banks to buy again and not to sell the stocks now, they are holding.

This is another case of manipulation. The Bangladesh Bank and the SEC did not act in time. They have been reactive, not proactive. They are now acting out of confusion with seeming incompetence. The Central Bank is not keeping the monetary policy on a steady path with a clear vision. It reveals too many vacillations that are likely to be counterproductive over time. Both Regulatory Agencies (BB and SEC) should act together and get out of the blame game. The market had already enough of it. No more, please. Show your policy competence and confidence to steer the stock market and the economy. Please do not throw them into uncharted water, any more. Perceivably, media reports might have contributed to the prevailing confidence crisis. However, it was not overblown. They simply reported the facts. I do not identify the current episode with the so-called irrational exuberance. Small investors were not irrational per se, rather big players in the market sold illusion to them unjustifiably in order to victimise those ignorant folks for own colossal gains.

Dear writer, this is not correction. In this market there are lots of stocks having good PE ratio. This is sheer crash. No doubt the market is overheated but overpriced stocks can be corrected gradually. Financial institutions invested more money…where was the regulatory authority then? Regarding industrial loan, does government assure of electricity/gas? So why do people invest in industrial sector? It was just a wrong trend of government.